I’ve often heard people talk about “investing ethically”. What they mean, of course, is that they believe in supporting companies that they feel do good things, or they at least avoid supporting companies that do bad things. The one crucial problem with this line of reasoning is that except in a few special circumstances, investing in a company doesn’t really “support” it at all.

This can be illustrated with a few examples. Let’s say that you are a wealthy investor and that company A sells children’s books. You feel that company A’s books are educational, wholesome, and deserving of your financial support. They earn $7 million per year, and are currently valued at $100 million dollars. Seeing some growth potential in the company and wanting to support their cause, you buy $1 million of company A’s stock. The question is, how much did company A earn from your million dollar purchase? The answer is nothing. They still earned $7 million dollars this year; the only difference is that you now own 1% of company A and they will pay you next time they issue dividends.

If company A’s business improves, you will make money from your investment; if it deteriorates, you will lose money. Either way, your effect on them is non-existent unless you buy the stock directly from them (e.g. in an IPO), or they decide to sell more shares after you’ve made your purchase. Had you simply bought a million dollars worth of books, you would have increased their earnings from $7 million to $8 million and had a huge effect on their business for the year. Investing though, won’t help them a bit. If their earnings falter, you’ll lose your money, but it won’t have done them any good.

Likewise, if you don’t want to support company B which sells oil refinery equipment, you’ll have to find a better way than just not buying their stock. In fact, even selling their stock would do nothing to them in the long run. Suppose Bill Gates, Warren Buffet, the Vatican, Opera Winfrey, and the estate of Colonel Sanders managed to secretly buy all of company B’s stock and then agreed to sell all of it on the open market at a prearranged time.

The stock price would plummet, yes, but company B’s earnings and business prospects would stay the same. Opportunistic people, such as myself, would recognize how under-valued the stock was and buy it at a fraction of its true worth. Very quickly, the stock price would climb back to its actual value, give or take a factor of two, and our sneaky “pentavirate” would have accomplished nothing more than throwing away their own money.

When it comes to ethics and corporations, I have to make rational choices. That doesn’t mean I don’t think the effect of my actions is too small to matter. It just means that making investments based on ethical evaluations of companies doesn’t make much sense. If there’s a company I want to support, I’ll buy its products. If I don’t want to support a company, I won’t buy its products. If it’s a really evil organization, such as the RIAA, I might even try to get others to boycott it or write to my congressional representative. However, barring an IPO or an SPO, I’d buy stock in any of the RIAA’s member companies if I found the valuation attractive. Heck, I might even be able to influence them with the voting privilages that came with the stock…

Comments

Basically, I agree with your reasoning — on the whole, ethical investing represents a net-transfer of wealth from those who invest “ethically” to those who don’t with no real effects on the companies in question unlike other consumer-based actions that actually hurt their bottom line.

But I do believe that you’re simplifying the situation a little. A lot of companies do “care” about their stock prices, not because it impacts the health of that company, but because a lot of the chief officers of that company who controls its general direction also happen to hold a lot of company stock. It’s also true that a lot of companies do stock buybacks after the IPO, effectively becoming big investors in themselves. In both those circumstances, it is possible that the reduced demand caused by the ethical investors do in fact end up affecting corporation behavior.

Of course, not always in the way they intend. Wal-mart, for instance, have a stock price that is inexplicably depressed if you look at the numbers [caveat: my friend is the source on this, I don’t know enough to verify whether there are not some other reasons]. Their bad corporate image could well account for this gap. But instead of improving their ethical standards, Walmart executives decided to go with feel-good ad campaigns about how walmart is great for the community instead.

That’s true. In those situations, the stock price will have an effect in the short term (though in opposite directions). Company officers who are selling stock want the price high, and companies doing buy backs want it low. Buying a large quantity of stock right before a company officer decides to sell, or selling a lot right before a company’s scheduled buyback would help them. In the long run, though, no large purchase or sale would have any effect on the price. In order to have a real effect on a company through stock purchase or sale, the timing would have to be perfect.

As for Walmart (NYSE:WMT), it’s currently trading at $48/share, for a P/E of 18. The P/E used to be much higher, but I think a lot of that was due to the fact that it used to have so many more growth opportunities. Right now, Walmart still has some room left to run in China, but across much of the globe, its growth is getting pretty sluggish. It’s just so big that it’s hard to say if it can achieve 18% the yearly growth it would take to justify its P/E. It deserves some premium for being the market leader, but it’s hard to say how much. I don’t see Walmart (the stock) as a bargain at the moment, but it’s not as expensive as it has been.

I think that the timing should be irrelevant…after all, one cannot hope to hold down the stock price with one’s own purchasing power. The idea is that if enough ethical investors acted as a block, they will permanently depress the stock price. Of course, that’s “great” for the company when they do the buyback, but the point of doing the buyback is to bet on the fact that your company’s stock will eventually pick up.

As for Walmart and whether it is underpriced…I defer to your authority.

Even with many many investors (or in my example, a wealthy “pentavirate”), it isn’t possible to permanently depress the value of a stock. There is an equilibrium range for the price of any company, and if you drive the price of the company below that range by selling or even short selling, then investors such as my self just buy it back up. Stocks aren’t lotteries. For long term investors, buying stock isn’t just a bet that the price will go up. It’s a purchase of part of a company.

For example, let’s say evil company X earns $10 million per year, has one million shares priced at $100 each (for a valuation of $100 million) and has 30% insider ownership. Let’s say that somehow, you and millions of other ethical investors manage to drive the price all the way down to $10 per share. The company is now worth only $10 million. The company then decides to spend $5 million of its $10 million in yearly earnings on buying back their own shares. Now the number of outstanding shares is cut in half and the insiders own 60% of the company. Now instead of owning $3 million of the $10 million earned each year, they own $6 million of the $10 million their company generate each year. Even if you somehow convinced every investor on the planet not to invest in company X and the price stayed at $1/share forever, the insiders controlling it would make twice as much money from all future company profits as they would have if they hadn’t been able to buy back their own shares at such a bargain.

The above example was simplified. In the real world, nothing anywhere near that extreme would happen. The idea does apply, though.

Again, I completely agree with you in principle, but I don’t think stock prices in this country are always in lines with what’s dictated by profit/earning ratios and other measures like that. Prices are driven by speculation and demand for stocks that are deemed hot in a way that is very often decoupled from earnings.

Now, you argue that the company does not care about its stock price, and that a CEO should relish artificially low stock prices because it gives the opportunity to do buybacks and let insiders get huge profits. But is that what’s really happening? No. Corporations are anxious about their stock prices and sometimes do dumb things like mergers that hurt the long-term prospects of the company simply for a quick goose in the stocks.

So what am I saying here? That stock-shunning only works (partially at that) as a social corrective when markets are irrational and CEOs are short-sighted? Maybe. Either way, I think we agree that other means that hurt the business’ bottom line are more effective agents for change.

I did not say that companies don’t care about their stock prices at all, nor did I argue that a CEO should “relish artificially low stock prices”. Obviously, anybody can take advantage of artificially low stock prices, not just companies doing buybacks.

I said it is impossible for sellers to “permanently depress the stock price” of a company, regardless how many sellers are working together towards that goal. Furthermore, even if it were possible, those sellers would just be giving their money to anyone willing to take advantage of the artificially low price, including the very company they are trying to hurt.

I should add, though, that I’m no professional. I could be wrong about any of this stuff, so take it with a grain of salt. Better yet, find an example of when “boycotting” a stock actually did do serious financial damage to a company, or even just depress the value of its stock for several years, and tell me about it! I don’t mind being wrong. I just want to learn something from it if I am. 😀

Bruce

March 25th, 2006 at 11:32 AM

I aggree you might not be punishing the offending company by not purchasing thier stock, but in terms of “ethical investing”, the question might be are you okay with making a profit off of an activity that hurts your neighbor?. For example, companies that use a known harmful additive (without clear disclosure) to maximize shelf life , companies that sell a known dangerous herbal supplement/medication(again, without clear disclosure), companies that dump toxic waste in an area that is populated by “a lower class” because it is cheaper than properly disposing of the waste or companies that expose thier employees to health hazards because it is cheaper that providing the necessary saftey precautions increase the profit to the shareholders, but people are being harmed by the product/activity.

Bruce

March 25th, 2006 at 11:47 AM

Sorry about the typos above (long day, long week and exposed to high levels of co). I meant to say the company is not “saving” money but merely “transfering” the cost to others.

I agree with your assessment that socially responsible investing (SRI), either buying socially conscious companies or selling the less than savory ones, is unlikely to have a long-term effect on the stock price. However, I don’t think this is the main point of socially conscious investing. When you buy a stock you are buying a share of the company in return for a share of their growth potential and earnings stream – you are hoping to profit from their successes. People who engage in SRI just have a preference how these profits are made. It’s not about “supporting” a company but ensuring your ownwership complies with your ethical values.

Of course, a large scale wave of buying or selling, for whatever reason, that affects a company’s share price can impact the business itself since a company only goes public in the first place in order to access the capital markets – if they need to return to the market again, attaining capital will require more dilution. In some cases, this could even impact a company’s access to the credit markets as well.

A couple people have hit on my reason for investing ethically, but I’ll put it the way I think of it: if I buy stock in a company, then I own (part of) that company. Do I really want a company I own to do things that I think are awful?